Can a financial transaction tax prevent stock price booms?

• Published in: Journal of monetary economics Vol. 76; pp. S90 - S109
• Main Authors: Adam, Klaus, Beutel, Johannes, Marcet, Albert, Merkel, Sebastian
• Format: Journal Article
• Language: English
• Published: Amsterdam Elsevier B.V 01-12-2015; Elsevier Sequoia S.A
• Subjects: Asset price booms; Belief & doubt; Equilibrium; Financial transactions tax; Income redistribution; Investment policy; Prices; Securities markets; Stock prices; Studies; Tobin tax; Financial transactions tax; Tobin tax; Asset price booms
• ISSN: 0304-3932; 1873-1295
• DOI: 10.1016/j.jmoneco.2015.09.009

We present a stock market model that quantitatively replicates the joint behavior of stock prices, trading volume and investor expectations. Stock prices in the model occasionally display belief-driven boom and bust cycles that delink asset prices from fundamentals and redistribute considerable amounts of wealth from less to more experienced investors. Although gains from trade arise only from subjective belief differences, introducing financial transactions taxes (FTTs) remains undesirable. While FTTs reduce the size and length of boom–bust cycles, they increase the likelihood of such cycles, thereby overall return volatility and wealth redistribution. Contingent FTTs, which are levied only above a certain price threshold, give rise to problems of equilibrium multiplicity and non-existence.